The episode is a big reminder that European Central Bank’s aggressive policy measures are sending serious ripples throughout Europe and shaking up its smaller currencies.

UBS currency strategist Geoffrey Yu said that the move demonstrates the “serious policy dilemmas” that the ECB has presented the euro zone’s smaller neighbors.

In June, the ECB cut its key interest rate and announced a series of other measures to support economic recovery and bolster inflation. It now effectively penalizes banks for parking their excess cash at the ECB, making euro-denominated deposits less attractive, weakening the exchange rate (albeit not really against the dollar) and – in the process – driving up currencies like the Danish krone and, inevitably, the Swedish krona against the euro.

The Riksbank is not the first to flinch.

Norges Bank last month kept rates on hold but signaled that it may cut rates to revive economic growth.
“They all fear that deflation will be aggressively exported to their countries and there is now a race to the bottom to ensure that such price expectations do not become entrenched,” Mr. Yu said.

None of the analysts surveyed by the Wall Street Journal predicted such a large cut, so everyone was caught off guard. BNP Paribas says it was stopped out of its positive bet on the krona, while ABN Amro said it has removed the krona from its “conviction buy list.” Ouch.

Jane Foley, a currency strategist at Rabobank, describes the Riksbank’s move as “obvious push-back” of which we should expect more if the ECB opts for even more drastic measures, but in terms of conventional measures left available for the Riksbank, Daragh Maher, a currency strategist at HSBC, said that there is “little room for maneuver.”

“In extremis, the Riksbank and Norges Bank may need to think about the option of adopting an exchange rate target or floor, which is now the case in Switzerland and the Czech Republic, while Denmark uses a currency board,” Mr. Yu said.

He notes that if Sweden moves in Switzerland’s direction, there would be significant implications for currency markets “as investors contemplate the sudden emergence of a big marginal reserve accumulator.” In other words, if a number of serious central banks in Europe start buying euros in bulk to weaken their own currency, then how on earth does that play out?

Already last month, David Bloom, global head of currency strategy at HSBC, said that even after a rate cut, the Riksbank would likely be required to adopt a “more radical strategy.”

“Switzerland has shown that a currency floor can be a successful strategy… Unconventional easing may warrant an unconventional response,” Mr. Bloom wrote in a note to clients.